Key Differences Between Business and Personal Loans
Are you a small business owner in need of some cash but unsure if a business loan or personal loan is your best bet? The right fit will depend on a few factors including what you qualify for and which loan product offers the best overall value for your situation.
Let’s take a closer look at the differences between personal loans and business loans, and how to decide which is best for you.
Business loans vs. personal loans
Both business and personal loans can provide entrepreneurs with a loan amount to grow their ventures. However, they vary when it comes to the loan types available, eligibility requirements, and more. Here’s a closer look at both options.
Personal loans are a credit product extended to individuals for their personal use. You are not required to be a business owner to get a personal loan but you usually have to prove that you have a source of income.
Personal loan uses
Personal loans can be used for a wide range of purposes from paying off expensive debt and making home improvements to helping to cover business expenses. As long as the lender doesn’t restrict a particular purpose and it’s not illegal, you have free rein with how you use the funds.
To qualify for a personal loan, you’ll need to fill out a loan application with a lender and share your personal information including your name, address, social security number, personal finances, and proof of income.
During the application process, you may also need to submit the following documents:
- Bank statements: A bank account is often required and you’ll be asked to provide statements from the last three months.
- Proof of income: Lendersmay request pay stubs, tax returns if you’re self-employed, or a W2.
Personal loan lenders usually assess your personal credit score, debt-to-income ratio, and income stability to decide if they will lend to you or not. The amount of risk you present will determine if you get approved, the loan amount you can get, your interest rate, and possibly the fees you’ll have to pay. For example, if you have a fair credit score of 600, you may get approved but will have to pay more for the loan than someone with a good or excellent credit score in the high 700’s. The better your credit and financial situation, the higher the loan amount and lower the interest rate you’ll likely get.
When looking into personal loans, you’ll typically come across two main financing options:
- Term loans: Get a lump sum upfront and repay it over a set termwith interest.
- Lines of credit: Get access to a lump sum in the form of a credit line that you can withdraw from as needed and only pay interest on the amount you withdraw. The credit line will be available for a set period after which full repayments will be due over a set term.
In addition to these types of loans, the terms of personal loans can vary. For example, loans may be unsecured or secured. Secured loans use a borrower’s property as collateral for the loan while unsecured loans rely on the borrower’s creditworthiness. Additionally, personal loans may have fixed or variable interest rates, and some may be marketed for a specific purpose like debt consolidation or home improvement. A student loan is also technically a personal loan.
Now, let’s move on to business loans. Business loans are loans that are extended from lenders to business owners to be used for business purposes.
Business loan uses
Typically, lenders like to see business loans invested in an initiative that helps to grow the business and increase revenue. For example, business lenders may ask what you need the money for with options, including:
- Working capital
- Buy equipment
- Buy inventory
- Cover payroll
- Real estate
- Acquire a business
Be sure to check with your lender for approved loan uses and any restrictions that may apply.
To qualify, you’ll typically have to meet eligibility requirements related to your annual revenue, time in business, personal credit score, and possibly business credit.
Lenders will often request the following documents during the application process:
- Business finances/Time in business: Two years of federal tax returns, three months of business bank statementsto verify cash flow, and a profit and loss statement.
- Personal Income: Two years of personal tax returns and three months of personal bank statements.
- Credit: Lenderswill typically check the personal credit reports of all borrowers. They may also check your business credit score.
- Other: In some cases, you may have to submit additional information for your business. For example, the SBA may ask you for a business plan, projections, etc.
Most lenders will only approve established businesses. Startups and new business ventures will often have more trouble getting a business loan, however, the SBA does have some programs available.
That said, eligibility requirements vary from one lender to the next so be sure to check them out. Just because one lender denies you doesn’t mean the next one will. Some are more flexible than others. Further, if you’re concerned because you haven’t started to build business credit yet, don’t worry. Many lenders rely on personal credit instead.
Business loans come in a variety of forms to suit different situations. Here’s a look at the different types of business loans:
- Lines of credit: An amount of money your business can access on an as-needed basis. Lenders set your business line of credit based on your financial and credit profile, and then you can use it for a set period of time. You usually only pay interest from the date of withdrawal. Once the draw period is over, a repayment period typically starts in which you repay the principal amount and interest.
- Term loans: A lump sum amount sent to your business and repaid over a set term with interest. Term loansare often unsecured and granted based on a business’s financials and a personal guarantee.
- SBA loans: The S. Small Business Administration (SBA)has a variety of loan programs to support small business growth in the U.S. SBA loans are typically offered through third-party lenders while being backed by the SBA. The SBA will help to cover the costs if a borrower defaults. The backing lowers the risk for the lender and enables a lower interest rate and more flexible loan terms.
- Equipment loans: Secured loans to help businesses buy equipment for company use. These loans typically involve a lump sum given upfront to purchase the equipment and then repayments over a set term. The equipment acts as collateralfor the loan which can make qualifying easier.
- Merchant cash advances: An upfront lump sum loan that is repaid by taking a percentage of your future sales. These advances are often used by businesses that have consistent credit card sales or sales through a third-party payment processor like PayP
- Business credit cards: Business credit cards are a type of loan that is revolving. You’ll receive a credit line that you can use, repay, and use again. If you don’t pay off the balance within the billing period, you can pay it off in monthly payments but will pay interest.
- Invoice financing: If you invoice your clients for payment, invoice financing enables you to use your unpaid invoices as collateral for a loan. You can get paid quickly by a lender but will have to pay them a percentage of your invoice amount when it’s paid.
- Invoice factoring: Another funding option if you invoice clients is to sell your invoices to a factoring company for a percentage of the amount owed. You’ll get the cash (less the fee) upfront and they’ll collect the money when your client pays.
The right business loan option for you will depend on your business needs. For example, if you use a merchant service provider, like a credit card and payment processing solution, you may want to look into merchant cash advances. However, if you need a line of working capital that you can access as needed over time, a line of credit would probably be best. Knowing all your options is an important first step. Then, narrow them down and compare the products that will work for you to find the best deal.
Final verdict: Personal or business loan?
Both business loans and personal loans can come in handy in different situations. If you’re still not sure which one is best, here are two main questions to ask yourself:
Can you qualify for both a business and a personal loan?
This is an easy way to narrow down your options. Can you qualify for both? A personal loan will be solely reliant on your personal credit history and income. The business loan will require a bit more. If you are a startup or your business hasn’t yet reached the two-year mark, a personal loan may be the easier route. If your personal credit isn’t great but your business case is strong, you may be able to get a business loan but not a personal loan. Either way, a good first step is figuring out which you can get.
If you qualify for both, which better suits your situation?
If both a personal loan and business loan are options, it’s time to dig into the details of the offerings. Consider factors such as the loan types, amounts, fees, interest rates, terms, overall cost, time to funding, and customer service ratings. You want to find the least expensive loan solution that best suits your situation. For example, with a business loan, you may be able to borrow more money at an equally competitive rate. In that case, it’d be the better route.
Where to shop for a small business loan
If you’re interested in learning more about business loans and what you can get, the process has never been easier. Many online lenders have cropped up, streamlining the loan application and disbursement process. All can be done online without needing to visit your local bank or credit union.
At Biz2Credit, we can tell you if you’re pre-qualified in seconds. We’ll collect some basic information about your business and credit score, then will match you with business loans that will be a good fit. You can compare your options to see which is best and if it beats any personal loan offers you’ve received.
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